Give the wealthy a tax break to encourage affordable housing? Gavin Newsom wants to try it

A provision of Trump’s 2017 tax bill helps the wealthy put off paying some taxes. Now California might use it to help build affordable housing.

The opportunity zone program lets investors take money they’ve made from selling something like stocks, real estate, or art, and put it into a fund that invests it in projects to uplift economically distressed communities.

Investors can defer paying their federal capital gains taxes on those investments until the end of 2026 or whenever they sell or exchange their investment – whichever comes first. The longer an investor keeps money in an opportunity zone investment, the smaller their tax liability becomes. If they keep an opportunity zone investment for 10 years or more, they don’t have to pay any taxes on the gains they make from their investment.

“A lot of us, at least on my side of the football, said, ‘That actually sounds like a good idea. Wait a sec, it came out of which administration?’” Newsom said at an opportunity zone conference at Stanford on Monday. “I’m still trying to get my arms around it....My original thought was let’s focus with a sense of urgency on the two values that define this moment - issues of affordability and housing and on the issue of climate change.””

California holds 879 opportunity zones, about 10 percent of those in the country. But because it hasn’t matched the federal tax structure, it’s at a competitive disadvantage with states that have.

While investors might be able to get a federal tax break if they invest in California opportunity zones, they still have to pay state income taxes on the gains, which are the highest in the country at 13.3% for the state’s top earners.

JP Walsh, finance director of Panoramic Interests, a Bay Area real estate developer and opportunity fund, said much of the interest in opportunity zones comes from “high net worth individuals. . . and what those people are hypersensitive about is taxes,” he said.

“They have all the benefits of the federal tax return, but when you compare a New York o-zone project to a Bay Area or a California o-zone project, the New York project is at a significant advantage because on an actual tax return it’s just more attractive,” Walsh said.

State Treasurer Fiona Ma said her office is waiting on additional regulations from the IRS before it determines exactly California will conform with federal law, but said investors are enthusiastic about the idea of it.

“There’s a lot of excitement. So when I did say the Governor wanted to conform at one of the opportunity zone conferences, people stood up because a lot of the investors in the room are from California and they would rather invest in projects there in their backyard,” Ma said. “If the Legislature sees fit, then I think that’s going to be a huge win for California.”

Others aren’t optimistic that the change would produce more affordable housing.

“This policy isn’t, I don’t think, very well designed to do what it’s putatively meant to be doing, which is to help people in poorer neighborhoods,” said Timothy Weaver, assistant professor of urban policy and politics at the University at Albany in Albany, NY. “It’s going to help wealthy people primarily who don’t want to pay capital gains tax on investments. They’re the number-one beneficiaries.”

Weaver said the kind of incentives the program offers could make investors want to invest in “market rate high-end housing” instead of affordable housing in order to maximize their profit. He also worries that it will simply lead investors to invest in areas that would attract capital even if they weren’t designated opportunity zones.

The Legislative Analyst’s Office recently released a report on tax conformity which says something similar, asserting that federal tax law tends to impact investors’ decisions more than state tax law because of higher federal rates.

“Any state tax benefit provided would be a ‘windfall’ to investors because they likely would have made the investment even without the state benefit,” the report said. “Moreover, if the federal tax incentive is insufficient to encourage investment in affordable housing and green technology, a similar state tax benefit likely would not change investors’ choices.”

USC public policy professor Gary Painter argues that there are many ways for California to leverage federal opportunity zone program investments that don’t involve losing state tax revenue, like streamlining approval processes for developers.

“I suspect that’s actually worth a lot more than just reducing the capital cost a little bit,“ Painter said.

At Stanford, Newsom acknowledged the skepticism, saying to investors, “I also want to thank all of you for your interest.”

“I hope it’s not just to make a quick buck,” he said. “Let’s be honest, because that’s the fear.”